PTT

PTT Plc
At PTT’s recent briefing, the company managed to partially alleviate the concerns of investors and analysts on the growing losses
from NGV and LPG, and its overseas expansion strategy. We believe these worries should be offset by the solid earnings of its associates.
We returned from the meeting less concerned about PTT’s subsidy loss caused by uncertainty in the government’s energy policy.
Its clearer expansion plan into coal and bioenergy provides greater visibility to its growth outlook. We maintain our Outperform rating and
our SOP target price of THB391. Earnings growth from associates is a catalyst

What Happened
During PTT’s analysts briefing, CEO
Mr Pailin and CFO Mr Surong
addressed three key investor concerns.
The executives provided a clearer
picture of the subsidy loss from NGV
and LPG; explained the company’s
long-term international expansion
plan; and talked about PTT’s focus on
the coal business. We believe this
meeting has helped to lessen
concerns over PTT’s earnings outlook.

What We Think

We are now less concerned about
PTT’s subsidy loss, and more positive
on its expansion plan with its focus
on coal, bioenergy, and gas supplies.
Of these, the foray into gas offers the
most promising outlook, in our
opinion, with potential growth
opportunities in Indonesia (with
Pertamina and Natuna field),
Cambodia on OCA area, and
Myanmar via PTTEP.

What You Should Do
While we are now more positive after
getting a clearer picture on these
three concerns, we believe the
uncertainties surrounding the issues
will remain key drags on PTT’s share
price over the next few months, at
least until the government can
potentially relieve the price cap by
mid-2013. We however think that
downside for PTT is limited given that
it is trading at 7.3x CY13 P/E vs. 10.9x
for regional peers.

Positive message from management
PTT’s management is expecting the company’s earnings outlook to improve in
2013 and 2014 with key growth drivers coming from its associate E&P and
downstream refinery and petrochemical businesses. In doing so, CEO Mr Pailin
and CFO Mr Surong addressed three key investor concerns:

Concern #1: NGV and LPG subsidy losses
While we still expect the loss from the subsidy to widen in 2013-14 (we believe
this loss will increase in 2013 to THB20bn, up from 17.4bn in 2012), we think
the scope for the rise will be limited by two key factors. First, PTT reiterated
that it has capped the number of NGV stations to around 500, with 30-40% of
these located near a gas pipeline. PTT believes limiting the number of NGV
stations cap demand growth for NGV in 2013. Second, PTT expects the
government to at least partly relieve the NGV price cap to be above the current
price of THB10.5/kg, on the grounds that the potential NGV supply shortage
will act as a catalyst for the price liberalisation ahead of the AEC in 2015. We
project that NGV demand volume will grow by 6% yoy in 2013 (down from 15%
in 2012) but the gas cost will rise by THB1/kg to THB17/kg in 2013 driven by
higher gas cost from LNG and the Gulf of Thailand.

Concern #2: International expansion
PTT is expected to grow its business via acquisitions and organic growth
overseas. First, on trading front, PTT aims to grow its trading business beyond
oil & gas, petrochemical, coal, and palm oil products, into the bioenergy
products of ethanol, biodiesel, and other green energy sources. This, in our view,
should help strengthen its presence in the international markets, particularly in
ASEAN where PTT intends to grow its brand recognition via its superb
marketing and gas station business, which has been a proven success in
Thailand. This business could help propel its main business of refinery and
petrochemical sectors on the back of increased market awareness and
penetration ahead of the AEC market integration in 2015.

Second, on its core gas business, PTT’s plans to grow its gas supply in three core
countries – Myanmar, Indonesia, and Cambodia - over the next 10 years should
help to reduce its growing reliance on high-cost imported LNG, which is
projected to grow to 10mtpa (1,400MMSCFD or 31% or current gas demand).
Its first target is the giant Natuna gas field in Indonesia for which PTT is
currently in negotiation with Pertamina for a project development JV.
The second potential target could be Myanmar where PTTEP has already
established a strong presence with two operating production fields of Yadana
and Yetagun, and one project of M9 under development. PTT expects to
increase its gas production in Myanmar via more JVs, and we see this as
achievable given PTTEP’s long-established relationship with the Myanmar
government.

The third source, while currently remote, could become a positive surprise as a
large gas supplier in the future. PTT believes there is a high probability of a
large gas reserve existing in the Overlapping Claim Area (OCA), sitting adjacent
to Thailand’s current producing gas field area.
The OCA is a 27,000 sq km offshore area estimated to contain up to 11 trillion
cubic feet of natural gas (2x the size of Thailand’s gas reserve) and
underdetermined quantities of condensate and oil. The OCA is bounded by the
Cambodia claim of 1972 (western boundary) and the Thai claim of 1973
(eastern boundary line), as well as the 1991 Cambodian-Vietnam maritime
border (southern boundary).
What is the problem? The issue of revenue sharing was a key problem
identified by both Thai and Cambodian sources. Both countries have presented
competing proposals in earlier talks. Cambodia proposes dividing the disputed
area in a checkerboard fashion, creating at least 14 different blocks. Revenues
and management of the blocks would be shared equally on a 50/50 basis. The
main Thai counter-proposal is that the disputed area be divided into three
strips running north-south, with the revenue from the central area to be shared
equally on a 50/50 basis. The share from the outer areas would be weighted in
favour of the country adjacent to that area, approximately 80/20 to Thailand
on the western side of the OCA and 80/20 to Cambodia on the eastern side of
the OCA.
Is the Thai proposal unfair? In the absence of firm data on reserves in the OCA
(exploration not being allowed given the ongoing dispute), experts have
indicated that it makes intuitive sense that most of the exploitable reserves are
located towards the Thai side of the OCA. This is because the Pattani basin, the
oil field which contains most of the offshore oil and gas reserves in undisputed
Thai waters, extends into the OCA. Conversely, geological formations in oil
fields on the Cambodian side of the border have made drilling there challenging
and uneconomic in some instances. The result of this situation is that the Thai
proposal for revenue sharing favours Thailand, given the balance of the
reserves that can be economically drilled sit on the Thai side of the OCA.
Could the concept of a Joint Development Area be contemplated by authorities
of both countries? The concept of a Joint Development Area (JDA) seems to be
the only realistic solution to both countries’ overlapping claims in the Gulf of
Thailand. The concept of a JDA, according to a Thai academic familiar with
border disputes, is the best – if not only – solution to the political difficulties in
Thailand surrounding the potential loss of sovereignty. This is because the
concept of the JDA does not necessarily mean that Thailand or Cambodia have
to formally relinquish claims over territory. Rather the JDA can operate while
ongoing issues surrounding demarcation can be discussed separately.

Concern #3: Coal acquisition and growth
After the successful acquisition of a 91% stake in Singapore-listed coal producer
SAR, PTT aims to expand its coal production from 1.9mtpa to 3mtpa over the
next few years. PTT believes coal energy sources should remain the global
choice of energy, given its abundance and cheapest cost among energy sources.
Management believes that the low-price shale gas from US will not be a key
threat to coal demand outlook. Hence PTT aims to raise its coal production by
2-3x over the next five years from M&A. We believe this move will be
value-enhancing to PTT over the long-term period given the cost
competitiveness for coal.

Attractive valuation but overhang in the short-term
While we expect the current NGV subsidy issue to remain a key drag on the
share price, we believe rerating could emerge once the price caps for NGV are
relieved by mid-to-late-2013. PTT is trading at 7x CY13 P/E, a deep discount to
regional peers at 10.9x P/E due to its current widening subsidies. We expect
this discount to narrow once the subsidy is relieved in 2013. Our end-2013
target price of THB391 is based on SOP, and incorporates a 20% discount to
reflect the holding company and the subsidy. Outperform maintained